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UK Flawed Inflation Measure Stoking Wage Price Spiral and Worker Discontent

Economics / Inflation Jul 16, 2008 - 02:22 AM GMT

By: Nadeem_Walayat

Economics UK inflation continues to accelerate after busting through the 3% ceiling in April, and hitting 3.8% in June. However the real rate of inflation being experienced by consumers is a function of the actual purchases made rather than the price of the wide ranging basket of more than 110,000 goods and services that the CPI inflation rate attempts to track. The reason for this is that consumers are feeling the relentless impact of rising fuel, energy, food and credit costs whilst at the same time impacted by asset price deflation as the housing market completes its 10th month in a bear market that has seen house prices now decline by nearly 10% from the August 2007 high or by an average of £20,000. In addition to this the UK stock market has lost 20% of its value from its 2007 highs.


Under these circumstances the consumers are less inclined to buy luxury goods and large ticket items which has impacted the high street as recent retailer statements of profits warnings such as by Marks and Spencer's illustrated. Therefore this has resulted in falling prices of luxuries due to the reason that prices are being cut due to the lack of demand and therefore masks the real rate of inflation in favour of government policy. The CPI also excludes large components that are increasing at rates far beyond the 3.8% official rate such as mortgage interest rate payments which have risen by 10%, and council taxes again up by amount greater than the CPI inflation rate, similarly other taxes are excluded such as stamp duty. Perhaps everything that is excluded from the CPI should become tax deductible so as peoples experiences more closely match the official CPI inflation rate?

The only way to truly track the real rate of inflation would be to follow the month to month actual purchases of several hundred families and individuals and weight the component goods and services in favour of changing consumer buying habits, which would result in a real rate of inflation rather than the current weighted average of all goods and services that tends to produce an official inflation rate that is perhaps half the true rate of inflation.

In the meantime, as a stop gap measure for a long-time I have advocated that a truer measure of inflation is the RPI index plus 1%, this implies that a more accurate current rate of inflation currently stands at 5.6% against the 3.8% official CPI inflation rate. This is supported by market interest rates which continue to trade above the real rate of inflation despite the bank base rate of 5% giving a negative real terms rate of return.

The effect of this is a loss of confidence in the official inflation rate which results in worker discontent, as employers both public and private sector attempt to link wage rises to the discredited official CPI rate of inflation. We have already seen public sector discontent at wage deals of less than 2.5%, in April teachers striked for the first time in 20 years and all the signs are that the UK is heading for a summer of discontent.

Today further strike action will take place across Britain by council workers which will lead to closures of schools, day care centre's and refuse collection. The demand is for a greater pay rise than the 2.45% offered with public sector unions requesting an inflation busting 6% rise as a clear sign that the dreaded wage price spiral is a real possibility.

However government Ministers and MP's requesting public sector workers to accept pay deals far below the official rate of inflation voted themselves a 4.4% pay rise just two weeks ago, and have lost all credibility with the public who are fully aware that Members of Parliament have their 'Snouts in the Trough' where MP's routinely allegedly fiddle their expenses by claiming tens of thousands of pounds for day to day living expenses such as allowances for unnecessary second homes, and the so called £24,000 per annum John Lewis shopping list for household items. The MP's voted against reforms of their expenses earlier this month which was seen as clear evidence that it is a case of one rule for the MP's and another for the electorate.

Recent articles on UK Inflation

By Nadeem Walayat
http://www.marketoracle.co.uk

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Nadeem Walayat has over 20 years experience of trading, analysing and forecasting the financial markets, including one of few who both anticipated and Beat the 1987 Crash. Nadeem is the Editor of The Market Oracle, a FREE Daily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 150 experienced analysts on a range of views of the probable direction of the financial markets. Thus enabling our readers to arrive at an informed opinion on future market direction. http://www.marketoracle.co.uk

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